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Sri Lanka's economy onwards and upwards

The continuity inherent in incumbent President Mahinda Rajapaksa's election victory, based on early returns, is likely to further strengthen confidence in Sri Lanka's economic revival after decades of civil war.

Indeed, such is the present strength of the economy, which is forecast to grow as much as 6% this year, that few observers believed even a surprise victory by his chief rival, former army chief Sarath Fonseka, would have had a significant negative impact on the present boom.

In the eight months since the end of the civil war, the Sri Lanka Stock Market Colombo All-Share Index (CSEALL) has nearly doubled, reaching 3,591 the day before the presidential election on Monday. Over and above the natural peace dividend, the economy has been boosted by an US$141 million economic stimulus package, announced at the end of 2008, which helped to drive up the index about 25% between then and the official end of fighting last May.

Confidence has also been boosted by International Monetary Fund (IMF) approval of a $329 million loan to Sri Lanka, in addition to $322 million immediately lent in July 2009, part of the $2.6 billion stand-by arrangement approved at that time. That approval gave foreign investors firmer grounds for believing economic reforms and liberalization would continue on the basis of eased concerns over current account balances and the financing of external debt.

Even the arrest in mid-October in the United States of Raj Rajaratnam, one of the country's biggest investors, on insider trading charges, did little to dent the stock-price charge, with the benchmark index overcoming chart resistance in November-December last year from its then all-time high in mid-February 2007 of just above 3,000.

The share value of John Keells Holdings, the country's largest business group, has tripled since May 2009. With investments in transportation, hotels and food, the company typifies the national economy, slightly over half of which is usually driven by the service sector, with a quarter from manufacturing and the remainder from agriculture.

That balance changed during the third quarter of 2009 due to reduced agricultural production, so that services contributed nearly 60% of the economy and industry nearly 30%. Even so, gross domestic product (GDP) increased 4.2% year-on-year in the period, double the rate of the previous quarter and nearly triple the rate of the year's first half.

Fourth-quarter statistics are expected to show similar growth, in view of several large development projects being initiated on parts of the island most damaged by the civil war. Rajapaksa has said he will spend $4 billion, or almost 10% of GDP, building roads, railways and power plants in the north.

In an interview with Bloomberg Television, central bank governor N A L Cabraal predicted that the economy would expand more than 6% this calendar year, specifically saying that interest rates should be "sufficient to ... ensure that any risk of inflation is also curtailed".

Inflation is a considerable concern, given the various cash infusions and increased spending on the various new development projects. Inflation fears have historically been a preoccupation of foreign capital, as the country's inflation fate has often exceeded 20%, weakening the Sri Lankan rupee and deterring investment. Monetary policy is therefore exceptionally important in the near term.

Cabraal announced a week before the election that benchmark interest rates would remain unchanged at a five-year low to motivate investment aimed as post-war reconstruction.

Reconstruction of areas affected by the civil war is one of the four conditions of the IMF loan. (International assistance from various Asian and Group of Seven countries will also assist in post-war rebuilding.) Other IMF conditions are reduction of the fiscal deficit, augmentation of foreign exchange reserves and amelioration of the system of banking and financial supervision.

In October, Fitch Ratings maintained the country's ratings at B+ while revising the sovereign outlook rating to stable from negative. Fitch's revision was motivated by the expectation that the record high level of $4.3 billion in foreign exchange reserves at the end of September 2009 would rise to more than $5 billion by the end of the year. Standard & Poor's in October revised the country's "B" sovereign rating outlook to positive from stable.

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This page contains a single entry from the blog posted on January 28, 2010 4:06 AM.

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